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This article is intended to help you understand the basics of accounting and as a change agent help to exchange with the financial department of your company.

Generality of accounting

The purpose of accounting and cost analysis is to understand how the business generates its profit, can improve it, and how much it needs to produce for what profitability.

It is from the years 1970-80, that the accounting knows a revolution :

  • Beyond the industrial domain, it is also necessary to control the service activities. 
  • As companies become bigger and bigger, to understand and control them, they must be split into smaller entities. 
  • States are becoming aware of accounting concerns and imposing systems to control their effectiveness. 
  • The nascent computer, it becomes possible to multiply the operations more and more easily.
  • From the “Ford” model to current models, the proportion of direct costs to indirect costs in the cost of a product has been reversed. If at the beginning of the twentieth century, direct costs accounted for more than 70% of the total cost of a product, today, indirect costs represent the major part. More complex than direct costs, it becomes necessary to master them to understand profitability.

The concept of cost

The concept of cost is complex and is defined via 3 characteristics1 :

  • The object: defines the scope of our measure. We want the cost Of what ? “. This can be the cost of a function (HR service for example …), a product,…
  • Content : Each cost can take into account all or part of the charges. We can talk about all the charges (full cost), charges with certain characteristics (partial cost), their variability (fixed vs. variable cost) or their relation to the object (direct vs. indirect).
  • The moment : the costs can be calculated a priori via what we know or a posteriori via what we found.

Some definitions

  • Fixed cost :  it does not vary regardless of the business activity. 
  • Variable Cost :  It varies based on the business activity. 
  • Direct cost :  it can be attached without leaving any doubt about a specific product.
  • Indirect cost : It is not related to a specific product, but is related to the control of the product environment (commercial, management …). 
  • The breakeven point : it is the equilibrium point where the generated turnover can cover the expenses: it does not win anything but it does not lose either. 
  • Leverage :  This is the link between the revenue and the result. Clearly for a lever of 0.5, 1% of additional turnover generates 0.5% additional result. It is calculated as follows: (variation of the Result / initial result) / (variation of the initial turnover / turnover).

The main methods

There are various methods used by the administrative services to calculate costs, earnings and develop the Accounting Balance Sheet.

Full cost method

Historical method, it exists since the 16th century. The purpose of this method is to determine at each stage of a product’s life the cost associated with that stage. At each of these stages, we will distribute the direct and indirect costs to the various distribution centers according to the associated keys. Keys set more or less arbitrarily by the management controller.

For example, one of the keys often used is to allocate indirect production costs to the hour of direct labor. The sum of the costs divided by the number of hours produced makes it possible to find the unit cost.
This method has some disadvantages :

  • Indirect loads are distributed in a “linear” manner and this is a problem if the products are heterogeneous.
  • The choice of distribution keys is preponderant, at best it is questionable, at worst arbitrary. Using a different key can produce very different results. 
  • The risk of error is all the more important as the proportion of indirect load is high.

direct costing

It consists in imputing to each product the corresponding specific charges allowing us to obtain the fixed costs, and to group the fixed costs into an undifferentiated mass. So instead of measuring a full real cost, we put the fixed costs as charges for “structure “. The contribution of each activity to the coverage of these fixed costs will then be measured.

This method has some disadvantages :

  • If part of the process is outsourced, we will not be able to distinguish the actual costs of the process from the profit it makes. 
  • We focus on sales and their level of contribution, sometimes leading to dangerous pricing policies.

 

ACB Method

The ACB method takes a different view. It is about seeing the business as a suite of processes that drives the realization of a product, and that it is these processes that consume resources. The principle of the method is therefore the following: the cost objects (products, customers, …) consume activities (distribution, sales, order picking, production …) which themselves consume resources. We then find 3 types of charges :

  • Direct charges attributable to the product.
  • Indirect expenses attributable to the activity.
  • Indirect expenses not chargeable to an activity.

Indirect costs will be imputed according to “ the cost driver”, knowing that if the same inductor is common to several activities, then a group of activities will be defined..

Source

1 – C. Riveline (1980) – Evaluation des coûts : élément d’une théorie de gestion

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